Saturday, October 29, 2011

Science has not changed the laws of social growth or betterment. Science has not changed the nature of society, has not made history a whit easier to understand, or human nature a whit easier to reform. It has won for us a great liberty in the physical world, a liberty from superstitious fear and from disease, a freedom to use nature as a familiar servant; but it has not freed us from ourselves. It has not purged us of passion or disposed us to virtue. It has not made us less covetous or less ambitious or less self-indulgent. On the contrary, it may be suspected of having enhanced our passions by making wealth so quick to come, and so fickle to stay.

Saturday, October 22, 2011

And he sampled the time-winds, sensing the turmoil, the storm nexus that now focused on this moment place. Even the faint gaps were closed now. Here was the unborn jihad, he knew. Here was the race consciousness that he had known once as his own terrible purpose. Here was reason enough for a Kwisatz Haderach or a Lisan al-Gaib or even the halting schemes of the Bene Gesserit. The race of humans had felt its own dormancy, sensed itself grown stale and knew now only the need to experience turmoil in which the genes would mingle and the strong new mixtures survive. All humans were alive as an unconscious single organism in this moment, experiencing a kind of sexual heat that could override any barrier.

— Frank Herbert, Dune

There is something deeply wrong with this country, O Dearly Beloved.

We seem to have painted ourselves into a corner from which we cannot escape. Grass roots movements as diverse as the Tea Party and Occupy Wall Street implicitly recognize this fact and have sprung up in response to it. People from a broad spectrum of Americans less committed, strident, and/or crazy than these activists have shown themselves to be largely sympathetic to their discontent. Depending on where you stand, and which hobby horse you happen to be riding at the moment, our predicament can appear in any number of guises: corrupt crony capitalism, grossly overbearing and inefficient government, a broken financial system deeply riddled with self-interest, or a society-wide breakdown of personal responsibility and uprightness.1 Our so-called leaders—the very men and women we elected to get us out of this mess—cannot seem to tie their own shoes, much less offer a solution or even a direction in which to begin marching. Politicians are the only group of individuals more despised and less respected than investment bankers nowadays. Believe you me, as one of the latter, I can attest that that is a pretty damning indictment.

A common feature of many of our ills is the unmanageable size and complexity of our institutions and practices. This is certainly true of the government itself, our regulatory and tax systems, and our financial system. Part of this problem—size—may be an ineluctable outgrowth of the sheer mass of our nation and economy. One can certainly argue that size itself can lead to myriad ills. One can credibly entertain the notion that perhaps governing over 300 million people and managing a $14 trillion economy may be beyond the collective ability of any group of people, however intelligent or dedicated. Size certainly seems to have flummoxed the captains of my industry and their regulators in the most recent crisis.

But the bigger culprit, in my opinion, is complexity. Complexity makes things more difficult to manage. Complexity imposes substantial extrinsic costs, which must be expended simply to deal with complexity itself, apart from any underlying issues at hand. Complexity increases uncertainty, introduces distortions, and encourages mistakes. Want examples? Just think of the tax code, or the current state of the global financial system.

And yet we cannot seem to hit the rewind button on complexity. The latest example of this is the appalling complexification that the Volcker Rule—which was included in the Dodd-Frank financial reform act in order to prevent risky proprietary trading by government-backed depositary institutions—has undergone at the hands of those drafting the final regulations. The Beltway rulemaking sausage factory has turned what was a three-page initial proposal and a ten-page section in Dodd-Frank into a 300-page monster. A monster which, by all accounts, nobody loves.

Now, without a doubt a substantial portion of blame for this complexification can be laid squarely at the feet of industry lobbyists and banks themselves. They were the ones who lobbied so expensively and extensively for exemptions and extensions. They were the ones who no doubt insisted that the simple premise of the Volcker Rule was too simplistic to impose on a complex, interconnected industry without causing unacceptably expensive and potentially dangerous disruptions to established business practices.2 I’m sure they offered all sorts of eminently reasonable objections to straightforward implementation of a separation between proprietary trading and depositary lending, while simultaneously missing or pretending not to understand that THAT IS THE VOLCKER RULE’S ENTIRE FUCKING POINT. That these dickwads and their hired guns were able to impose their will to neuter this piece of legislation you may credit to another virulent contagion in our polity: the pervasive and poisonous influence of corporate and individual money on politics and regulation.3, 4

* * *

But the more general contributor to this legislative abortion is a structural one. Too many (all?) of the people writing these rules—both on the regulatory side and the industry itself—are lawyers. And lawyers have strong professional and cognitive biases against simplicity when drafting rules, laws, contracts, or indeed any sort of document designed to govern behavior. In all such situations, it is lawyers’ job, objective, and desire to minimize interpretation. They do this because they want to forestall future disputes and potentially expensive litigation by exhaustively codifying behavioral rules and spelling them out under every conceivable circumstance. Since when have you not seen a lawyer sorely tempted to insert a “provided, however” phrase into the simplest contract? Yeah, me neither.

A charitable reader like yourself might understand this impulse as a natural outgrowth of the pervasively litigious culture in the United States. For whatever reason, this tendency to sue first and ask questions later has led to a preponderance of rule-based, as opposed to principle-based regulation in this country. Nevertheless, codifying a principle as clear and straightforward as the Volcker Rule into a 300-page cookbook of recipes for what is and is not allowed in the financial sector is a wrongheaded exercise in futility. For one thing, exactly no-one can possibly anticipate how the financial markets and their constituent banks will change over the forseeable future. The global financial system is just too dynamic, and the likelihood that a piece of regulation penned in 2011 will be able to effectively anticipate and regulate financial market developments over the next several years is simply ludicrous. Investment banks themselves don’t know what kind of opportunities and threats they will face—and hence what they’re actually going to be doing—next quarter, much less in 2012 or 2015. How can we expect a static document drafted by a bunch of underpaid, cover-your-ass government lawyers who couldn’t recognize a proprietary trading desk if they were sitting at it to do so?

Because of this, regulators must have the ability to flexibly interpret and respond to changing conditions in the financial markets and the businesses of their regulatees.5 The relentless, rapid evolution of finance requires that financial regulation be principle-based, not rule-based. Reformed quant Emanuel Derman makes the case persuasively that we cannot understand financial markets using rigidly codified models. If that is true, how, then, can we ever hope to regulate them with a framework based on rigid, over-codified rules?

No points for guessing: we can’t.

* * *

So what does that mean for the Volcker Rule and financial reform in general? Well, one might argue that the best solution is to scrap that overlawyered piece of toilet paper and go back to the author of the eponymous rule’s own suggestion:

“I’d write a much simpler bill. I’d love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I’d have strong regulators. If the banks didn’t comply with the spirit of the bill, they’d go after them.”

Of course, this would be principle-based regulation. As Mr. Volcker points out, such a regulatory regime would require strong and well-informed regulators. I have made the same point, too many times to link to here, over and over in the past. Professor Derman is with me too. You would want ex-bankers, experienced in sales, trading, structured finance, and derivatives, who would work closely with regulated banks to monitor, understand, and control the changing nature of risks, activities, and opportunities in the markets. You would create performance incentives which completely insulate them from the results of their regulatees, and you would impose strict prohibitions on them returning to the industry before their active market and industry knowledge has gone stale.

Such regulation would demand close, realtime cooperation and consultation between regulators and industry participants. But if it is done properly, it should work out to everyone’s benefit. Regulators would get realtime information on risk exposures and market practices from their regulatees, and regulatees would receive realtime feedback and guidance from regulators on overall market developments and trends in risk management. Done properly, this model would not stifle innovation or profit-making. It would enhance it, while simultaneously reducing systemic risk and giving regulators early warning of developing threats to global financial security.

* * *

The Dodd-Frank legislation at over 2,000 pages is an abortion. The Volcker Rule at 300 pages is an abortion. They cannot succeed. If we cannot empower intelligent, experienced regulators to monitor and control the wholesale financial system using heuristic principles, we are fucked. Under the current financial regulatory system, and its proposed rules, we are all fucked. I will leave it to my Loyal and Long-Suffering Readers to decide whether that is a state of affairs which can be corrected. I suspect these pearls will be trampled like all the others into the muck of the pig wallow. Only time will tell.

In the meantime, we need to reinvent our rulemaking processes. Currently we make laws and regulations like oysters make pearls, except instead of starting with a tiny grain of sand and covering it with precious nacre, we start with a tiny pearl of sensible principles and cover it with layer upon layer of sand, grit, and detritus. This makes for ugly pearls, and lousy legislation.

1 For the avoidance of doubt, just in case you do care, I believe all of these things to be true. In my opinion, we are in deep doo-doo, and I see no-one on the horizon with a shovel.2 The premise behind these shenanigans is faulty. It is not the obligation of regulators to adapt, weaken, and modify regulations to minimize disruption to regulatees’ current business practices. It is the obligation of regulatees to modify their fucking business practices to comply with regulation. Jesus.3 There is a part of me that hopes the Volcker Rule is implemented in its currently bastardized form so mega-banks will be forced to expend ridiculous amounts of shareholder money and management attention complying with the Frankenstein’s monster they have helped create. Karma can be a bitch.4 As an aside, SCOTUS’s decision in Citizens United was an abortion of American jurisprudence. Just sayin’.5 My focus throughout this piece is on regulation of the wholesale financial sector; that is, investment banks, commercial banks, and other entities which provide services to corporations, institutional investors, hedge funds, and other such non-retail customers. I have nothing to say about retail financial regulation, since that is neither my area of expertise nor my day-to-day concern. Perhaps more rule-based regulation makes sense for consumer finance, since I suspect that field is less changeable and dynamic than the wholesale sector. But I defer to others with better knowledge on that topic.

Wednesday, October 19, 2011

“At pet stores in Detroit, you can buy frozen rats for seventy-five cents apiece, to feed your pet boa constrictor” back home in Grosse Pointe, or in Grosse Pointe Park,

while the free nation of rats in Detroit emerges from alleys behind pet shops, from cellars and junked cars, and gathers to flow at twilight like a river the color of pavement,

and crawls over bedrooms and groceries and through broken school windows to eat the crayon from drawings of rats— and no one in Detroit understands how rats are delicious in Dearborn.

If only we could communicate, if only the boa constrictors of Southfield would slither down I-94, turn north on the Lodge Expressway, and head for Eighth Street, to eat out for a change. Instead, tomorrow,

a man from Birmingham enters a pet shop in Detroit to buy a frozen German shepherd for six dollars and fifty cents to feed his pet cheetah, guarding the compound at home;

Saturday, October 1, 2011

As a dashing, handsome, witty, and debonair man-about-town, you might well imagine, Dear Readers, that I receive copious quantities of correspondence begging a minute of my precious time to address some issue or other. Often, it is some tyro who has read my work here, soaking up the reflected glory and excitement of the world of high finance while simultaneously eliding the irony, sarcasm, and disgust which naturally comingle therein. Said tyro is almost always looking to “break into” my industry, after having read my semi-ironic paean to investment banking (but missing the irony) or talking with his shell-shocked peers who already cling tenuously to 100-hour-a-week waterboarding slots at überbanks.

Notwithstanding its own not-insignificant challenges and the social opprobrium currently attached to investment banking by society at large, it’s hard to blame the poor dears:

Unlike, say, 99.6% of all other jobs available to a wet-behind-the-ears idiot in proud possession of little more than an expensive college degree, becoming an investment banker fresh out of college is a huge rush. Depending on what role they perform, new entrants just weeks into the job can participate in billion dollar underwritings, multi-billion dollar mergers, complicated cross-border restructurings, or devilishly complex trading programs, all the while possessing a level of experience formally known in the industry as “jack shit.”

In what other industry, I ask you, can a 22-year-old who just stopped wetting the bed three weeks ago participate in a deal which runs for weeks on the cover of The Wall Street Journal or the Financial Times? To be sure, he is probably doing little more than making copies, getting coffee, and trying not to look as stupid and lost as he feels, but at least he is in the room. Contrast this, if you will, with a fresh McKinsey recruit tasked with interviewing shop floor supervisors to develop a human resources inventory for a ball bearing manufacturer in East Bumfuck, Illinois. Or a pre-law student who spends 80 hours a week in a windowless basement cross-checking sale-leaseback contracts for a patent dispute in Moldavia. On average, young investment bankers spend less time traveling that management consultants and more time sleeping than corporate attorneys. Plus, they get to tell their friends and family that they carried Bruce Wasserstein’s bags. What could be better?

Unfortunately, from their perspective, many of the youngsters who contact me fear they do not possess the “right” degree from the “right” school which they believe will magically open the secret door into this wonderland of fun. Often they have tried and failed to pursue the standard on-campus recruiting paths or have come up short with the fearsome Human Resources harridans who guard the gates to Analyst or Associate recruiting. And so they reach out to Yours Truly, pleading for fifteen minutes of my time on the telephone or in person to give them the key to investment banking Valhalla.

For the avoidance of doubt, and for the benefit of the 20 hapless supplicants feverishly typing emails to me in response to this post, let me make this perfectly clear:

By the same token, it is a waste of electrons to send me your resumé. To whom would you suggest I send it? “Oh, uh, hi, Jerry at Goldman Sachs. I, uh, just happened to find this fascinating resumé lying on the fax machine. Would you mind taking a hard look at it? Wait. What do you mean? No, I don’t know anybody named ‘TED’. Why do you ask?” Consider my carefully defended pseudonymity an impermeable barrier to contact, referrals, or recommendations in the real world. Sorry, but that’s just the way it is.

However, as partial recompense for your pains, and to show I am not a completely heartless bastard, I am happy to share with you here the same advice I give aspiring applicants to my industry under my own identity.

First of all, having a degree in finance or economics from a top-ranked college or business school is not a sine qua non to get hired into investment banking. But I’ll not kid you: it helps. Especially now, when the industry is under severe pressure to retrench. Why? Because it acts as an easy screen for harried recruiters to winnow down the hundreds if not thousands of job applications they receive to a more manageable horde. Taken separately, a degree from a top school shows that other demanding institutions have deemed you worthy in the past, and a degree in finance, economics, or accounting shows you have an understanding of (and possibly a love for) the basic tools and concepts of our trade. Beyond that, they tell us almost nothing about whether you have the drive, passion, and capacity for our business. The only way we can find that out is by throwing you into the fire itself.

For I have seen dozens of top-ranked Ivy League graduates flame out (or worse, fizzle) over the years, mostly due to lack of energy, drive, or commitment to do what has to be done. Not because they weren’t smart enough; no, they were just too lazy or too entitled to get down in the mud and wrestle with the alligators, which is why we hire young cannon fodder like you in the first place. Survive the alligators, and you have a chance to rise into the haughty position of power, influence, and respect you feel you deserve. Don’t survive, and we’ll toss your mangled corpse out the back door onto a trash heap like a used Kleenex.

Did I mention investment bankers are heartless bastards?

* * *

What does it take to succeed in my business? You have to be really smart (don’t kid yourself on this one: it’s a high hurdle), determined, aggressive, and indefatigable. You have to be quick on your feet, too, because change is ever present in investment banking, and you have to be able to adapt to wildly different situations and volatile personalities. You have to learn how to work with financial statements, accounting concepts, and spreadsheets. You have to be good with people. You have to be a quick learner, because no school can teach you what you need to know and how to do it: investment banking is and always will be an apprenticeship business. And you have to (learn to) love the business. If you don’t, you’ll burn out: it’s just too hard and demanding.

Nowhere in that litany, you will notice, did I say you need a finance degree or an Ivy League diploma. Those help getting in the door, but they tell us little about whether you will be a good hire. So, what do you do if you don’t have the kind of credentials which almost guarantee you will get a first round interview? You have to be creative in your approach, flexible and clever in your campaign, and you have to convincingly demonstrate the traits of successful investment bankers I have enumerated above when you get in the door.

Reach out to people you know, ask for recommendations to senior bankers from your friends and family, request informational interviews with these bankers (but not unreliable, curmudgeonly pseudonymous bloggers), and go show them you have what it takes. Don’t give up. It will be very hard. But if you can get in the door, you will have proved to yourself and your employer that you have all the tools you need to make a positive impact.

And maybe one day, if you are smart, hard-working, and very, very lucky, you’ll be kicking some prissy Princeton prima donna the HR geeks sent you to interview out on his ass because you can’t trust him to bring back your coffee order from Starbucks correctly.

Good luck, campers.

* * *

(Oh, and one more thing. If you really want to stand out, it helps to be a girl. Just sayin’.)